Trump defies conventional wisdom

Sino-US ‘tariff wars’ are means to an end

President Donald Trump’s tweets and policy moves continue to confound the media as well as markets. Indian stock exchanges were spooked by his latest moves threatening a tariff war with China, even though India can only gain from a Sino-US trade dispute.

The conventional wisdom as propounded in serious media like the Financial Times is that the global economy has enjoyed unprecedented prosperity thanks to free trade and the free movement of capital. This was inaugurated after the second world war by the international General Agreement on Tariffs and Trade. The agreement comprised repeated rounds of mutual tariff cuts among developed countries and led to the establishment of the World Trade Organisation. But the idea that free trade is the best way of doing things has been embedded in many economists’ minds since the early 1800s, when the influential political economist David Ricardo argued in its favour.

Markets are short-termist and no traders want to be caught missing the ‘news’, even if Trump would call some of it fake. But there is also true news, the significance of which can be misread and, in the case of Trump’s pronouncements, is frequently misread. The problem is ‘conventional wisdom’, as economist John Galbraith called it – the miasma of common beliefs about how economies work.

Trump is the first post-war US president to challenge this wisdom. He campaigned on a protectionist platform and stood by his promises after the election. His threat to introduce tariffs has led to panic about an impending trade war between China and the US. Some people are reminded of the great depression of the 1930s, when Congress passed the protectionist Smoot-Hawley Tariff Act. Conventional wisdom says that the act worsened the depression.

Since the mid-19th century only the UK, impressed by Ricardo’s arguments, practised free trade, mostly unilaterally. All other developed countries used tariffs to industrialise, the US and Germany especially. Free trade became a policy norm only after the US became the leading industrial nation. Industrialisation of the Soviet bloc of economies happened under a trade bloc that put tariffs against imports from outside and had regulated trade within. The European Union is based on the same customs union principle, as are regional trade pacts like the North American Free Trade Agreement.

Trump is an unconventional thinker, as evidenced by his approach to North Korea. Six months ago, everyone was worried that he was about to start a nuclear war with Pyongyang. Instead, for the first time in the 65 years since the Korean Armistice Agreement, there are prospects of peace talks between North and South Korea and even between the US and North Korea. This is a result of Trump’s unconventional bargaining strategy. For the elite media in the US, this is deplorable behaviour. They praised former President Barack Obama’s policy of constructive neglect of North Korea. Trump knows his goal at the start of his negotiation but does not reveal his aim nor his path towards the destination. He has always boasted about his deal-making ability, but the US media dismissed it as an empty boast. Former President Ronald Reagan was likewise treated with contempt when he proposed his Star Wars missile defence initiative. Yet he achieved detente and the Soviet Union dissolved without a shot being fired.

Expect a similar result in Trump’s ‘tariff wars’. The president has announced his move but not dated its commencement. He has exempted the EU, concentrating on China. My supposition is that he wants to arrive at a comprehensive bilateral trade treaty with China, having withdrawn the US from the Trans-Pacific Partnership on his first day in office.

As in the case of North Korea, Trump views the world in a series of bilateral quarrels that the US has to settle, rather than the multilateral view that used to be the official US stance. The latter had prevailed since 1945, and the US provided the most important global public good – security for trade and transport across the world.

Trump has said the US cannot afford to pay unilaterally for that public good. This is why he wants North Atlantic Treaty Organisation countries to contribute their share. He wants to renegotiate Nafta. He wants a US-China trade deal. His methods are devious, but he will get there.

Lord (Meghnad) Desai is Emeritus Professor of Economics at the London School of Economics and Political Science, and Chair of the OMFIF Advisers Council.

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